Indexing run amok

Ask John Bogle, founder of the first index fund, what he thinks of the state of indexing today, and he doesn’t mince words — most of the products out there, specifically ETFs, “are not worth the powder to blow them to hell,” according to this article in Financial Planning magazine.

That’s because most ETFs, and many index mutual funds, are so narrowly premised on tiny market niches, that they aren’t index funds in the truest sense of the word, in the spirit of Bogle-inspired index investing. When he created the Vanguard 500 Index Fund in 1975, it was based on the idea that investing in a broad cross section of the market at a low cost would provide investors with returns that would keep pace with the overall market with the potential to out perform the vast majority of actively managed funds.

In the subsequent decades, hundreds of billions of dollars in assets under management have poured into index funds, which have become the preferred alternative for millions of retail and institutional investors.

I couldn’t agree more with Bogle’s thesis that these new ETFs, which make an overt or covert claim as index type products, are perverting the thesis behind index investing and have the potential to be extremely damaging to the portfolios of individual investors. Investors who are attracted to and invest in these funds likely have very little or no understanding of what they are investing in and even in “normal” market conditions, let alone a financial crisis, could find their portfolios sustaining major losses.

So what’s the answer? As always, buyer beware. There is no shortcut to wealth in the markets. Speculative products, especially those that seem to combine the familiar (indexing) with the exotic (alternative investing) are more likely to provide the opportunity to get poor quickly, rather than the sought after alternative.